On June 30, 2014, the Securities and Exchange Commission's (SEC) Divisions of Investment Management and Corporate Finance released joint guidance to address certain issues regarding proxy voting responsibilities of investment advisers and to clarify certain exemptions from the federal proxy rules relied on by proxy advisory firms. 

The guidance was released in a Q&A format and addressed a number of situations in which proxy voting rules and responsibilities may come into question.  The following presents a summary of the guidance discussed in the SEC release:

Proxy Voting Responsibilities of Investment Advisers

I. In addition to serving as fiduciaries to their clients, investment advisers are bound by Rule 206(4)-6 under the Investment Advisers Act of 1940, as amended (Proxy Voting Rule), which mandates that a registered investment adviser that exercises authority with respect to client securities must, among other things, adopt and implement written policies and procedures that are reasonably designed to ensure that the investment adviser votes proxies in the best interests of its clients.  An investment adviser should test the proxy votes cast to ensure compliance with the clients' best interests and the investment adviser's proxy voting procedures by, among other actions:

  • Periodically sampling proxy votes to check for compliance;
  • Reviewing a sample of proxy votes that related to certain proposals and that may have required more analysis; and
  • Reviewing at least annually the adequacy of its proxy voting policies and procedures to make sure they have been implemented effectively, including whether such policies and procedures continue to be reasonably designed to ensure that proxies are voted in the best interests of clients.

II. While clients typically delegate complete proxy voting authority to their investment advisers, clients and investment advisers may enter into a variety of proxy voting arrangements, some of which may include the investment adviser not assuming all of the proxy voting authority.  Investment advisers and their clients have the flexibility to determine their proxy voting arrangements, so long as they remain in compliance with the Proxy Voting Rule, including the following: 

  • The parties may agree that the time and costs associated with the mechanics of voting proxies with respect to certain types of proposals or issuers may not be in the client's best interest.
  • The parties may agree that the investment adviser generally should vote proxies as recommended by management of the company or in favor of all proposals made by a particular shareholder, absent a contrary instruction from the client or a determination by the investment adviser that a particular proposal should be voted in a different way.
  • The parties may agree that the investment adviser will abstain from voting any proxies at all, regardless of whether the client undertakes to vote the proxies itself.
  • The parties may agree that the investment adviser will focus resources on only particular types of proposals based on a client's preferences.

III. In considering whether to retain or continue retaining a proxy advisory firm to provide proxy voting recommendations, an investment adviser must determine whether the particular proxy advisory firm has the capacity and competency to adequately analyze proxy issues.  The investment adviser should consider, among other factors, the adequacy and quality of the proxy advisory firm's staff and the robustness of its policies and procedures, particularly with respect to identifying and addressing conflicts of interest.  An investment adviser's duties to evaluate proxy advisory firms also include an analysis of the proxy advisory firm's ability to make voting recommendations based on materially accurate information and to investigate and follow up on any errors made by a proxy advisory firm.

IV. In order to comply with the Proxy Voting Rule, an investment adviser that retains a proxy advisory firm to assist with its proxy voting responsibilities should adopt and implement policies and procedures that are reasonably designed to provide sufficient ongoing oversight of the proxy advisory firm in order to ensure that the investment adviser, acting through the proxy advisory firm, continues to vote proxies in the best interest of its clients.  A proxy advisory firm's business and/or policies and procedures regarding conflicts of interest may change after an investment adviser's initial assessment and could alter the effectiveness of such policies and procedures and necessitate a subsequent assessment by the investment adviser.  Accordingly, investment advisers should establish and implement measures reasonably designed to identify and address the proxy advisory firm's conflicts that may arise on an ongoing basis.

Exemptions from Federal Proxy Rules

I. A proxy advisory firm is subject to the federal proxy rules when it engages in a solicitation, which Rule 14a-1(l) of the Securities Exchange Act of 1934 (Exchange Act) defines as "the furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy."  The SEC has stated that providing proxy voting advice constitutes a "solicitation" that is subject to the information and filing requirements of the federal proxy rules.  Rule 14a-2(b) under the Exchange Act, under certain circumstances, provides for exemptions from the requirements of the federal proxy rules.

II. A proxy advisory firm offering a service that allows a client to establish, in advance of receiving proxy voting materials for a particular shareholder meeting, general guidelines or policies that the proxy advisory firm will apply to vote on behalf of the client does not qualify for an exemption under Rule 14a-2(b)(1) of the Exchange Act.  However, a proxy advisory firm that limits its activities to distributing reports containing recommendations and does not solicit the power to act as proxy for the clients receiving the recommendations may generally rely on the exemption.

III. A proxy advisory firm that furnishes proxy voting advice to a person with whom a business relationship exists may rely on the exemption from the federal proxy rules provided by Rule 14a-2(b)(3) under the Exchange Act.  This exemption is subject to certain conditions, including that the person gives financial advice in the ordinary course of business, discloses to the recipient of the advice any significant relationship with the company subject to the voting recommendation or any of its affiliates or a security holder proponent of the matter on which advice is given and any material interests of the person in such matter, receives no special commission or payment for the advice other than from the recipient of the advice or others receiving similar advice, and does not furnish the advice on behalf of any person soliciting proxies or on behalf of a participant in a contested election.

IV. In order to rely on Rule 14a-2(b)(3) under the Exchange Act, a proxy advisory firm that provides consulting services to a company on a matter that is the subject of a voting recommendation, or provides a client with a voting recommendation on a proposal sponsored by another client, must evaluate whether the relationship with the company or shareholder proponent is significant and/or whether the proxy advisory firm has a material interest in the matter to be voted upon.  The particular facts and circumstances will dictate whether a relationship is significant or what constitutes a material interest.  The SEC has stated that a relationship generally will be considered significant or a material interest will exist if knowledge of the relationship or interest would reasonably be expected to affect the recipient's assessment of the reliability and objectivity of the proxy advisory firm and the adviser.  The SEC has specifically noted that to the extent the identity of a shareholder proponent is not known to the proxy advisory firm, there is generally no duty to investigate the identity of such proponent.

V. In the event that a proxy advisory firm relying on the exemption provided by Rule 14a-2(b)(3) determines that a significant relationship or a material interest exists that would require disclosure to a client, the proxy advisory firm must provide such disclosure to the recipient of the proxy voting advice that would enable the recipient to understand the nature and scope of the relationship or interest, including the steps taken, if any, to mitigate the conflict, and provide sufficient information to allow the recipient to make an assessment about the reliability or objectivity of the recommendation by the proxy advisory firm.  Boilerplate language disclosure regarding a significant relationship or material interest is not sufficient for purposes of relying on Rule 14a-2(b)(3).

VI. The proxy advisory firm has an affirmative duty to provide the disclosure to its client rather than providing the information only upon request from the client.  The proxy advisory firm may provide the disclosure publicly or privately between itself and the client in any way that will allow the client to receive the disclosure at or about the same time that the client receives the proxy voting advice.

The SEC has advised that investment advisers and proxy advisory firms may want or need to make changes to their current systems and processes in light of this guidance.  The SEC stated that all changes should be made promptly, but in any event in advance of next year's proxy season.

To view the full SEC guidance, click here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.